A major purpose of a marketplace/trading exchange for commodities is to provide a central meeting point where people can buy and sell different commodity contracts. The people buying and selling at the market place are usually referred to as investors. The prices determined at the marketplace are generally interpreted as the “market value” of a particular contract. A marketplace for commodities in most cases attracts two different kinds of investors: hedgers and speculators.
Hedgers are people who invest money in a future contract to reduce the impact of future price changes in the market or to ensure access to a particular commodity in the future. Speculators, on the other hand, are people who invest money in the market when they see an economic benefit from it. For example, if a speculator is of the opinion that the price for a particular commodity contract is too high or too low, he may enter the market and buy or sell contracts in that particular commodity hoping to gain money from his transaction(s). The presence of speculators in the commodity market makes a positive contribution since liquidity in the market increases. Also, any “wrong pricing” in the market will be corrected by speculators, thereby enabling hedgers to hedge the market at a price, which is regarded as fair.
A commodity market that has had problems in attracting speculators is the electricity market. Where electricity is deregulated, electricity can be traded at different types of marketplaces. Contracts can be traded for short and long term periods. In both a sell and a buy situation, it can be necessary to hedge against price fluctuations.
A well-working marketplace needs active sellers and buyers where both parties are able to influence the market. In countries where the electricity market is deregulated, former monopoly companies still have a dominating role. Production companies are often in a position where they can use their position to set prices in the short-term contracts. This is particularly true for a real time balancing market, sometimes termed the “regulating market.”
Consumption normally has no influence on the real-time price, and settlement will not take place based on the real time price, but the expected real-time price will have some impact on spot prices. As a consequence, existing electricity markets have failed to adequately attract speculators. There is therefore a need for a market where both sides have the power to influence the real-time price as well as spot prices. This will ensure that prices at which contracts are traded are regarded as fair prices and are not easy to manipulate. When this is the case, the electricity marketplace will attract all type of investors, including speculators.
A de-regulated electricity market includes a marketplace to trade spot contracts (day ahead and/or on the day). Spot contracts are for delivery usually during one hour, and sometimes shorter, such as during one half-hour. In addition there is a balancing market which is used by the grid operator to balance/regulate the physical electricity flow on the grid. The members of this market are those who can regulate up/down on very short notice and for short delivery periods, for example, 5 minutes. This market is dominated by the big electricity production companies and has only one buyer, the grid operator.
Furthermore, in a de-regulated electricity market there is a possibility for the consumer to choose the supplier. However, delivery contracts are drawn up in a way that the consumer will not be affected by the actual (real-time) price, and thus, he will have no incentive to increase/decrease his consumption. For example, if the real time price increases from 10 cents per kWh to one dollar per kWh, the consumers will not know, and thus, will not have the possibility to reduce consumption. Neither will they know of the opportunity to increase their momentary consumption and benefit if the real time price drops to 5 cents per kWh.
The overall goal when designing an electricity system is to make the electricity market as efficient as possible. If the profit is bigger to reduce consumption than to increase production, investments should be made on the consumption side and the opposite should be done if there is more profit in building new production units.
Accordingly, de-regulated electricity markets are still very inefficient because:                1—A very strong position for a few very large companies controls the real-time prices (balancing market), and the balancing market prices influence prices at the market.        2—The spot market prices are usually used to close open financial positions in longer contracts leading to a lack of speculators providing the market with liquidity.        3—The lack of incentive for the consumers to act on real-time price changes in the electricity market.        